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LM07 Analysis of Long-Term Assets 2025 Level I Notes © IFT. All rights reserved 1 LM07 Analysis of Long-Term Assets 1. Introduction ........................................................................................................................................................... 2 2. Acquisition of Intangible Assets ..................................................................................................................... 2 3. Impairment and Derecognition of Assets ................................................................................................... 4 4. Presentation and Disclosure ........................................................................................................................... 6 5. Using Disclosures in Analysis ......................................................................................................................... 7 Summary ...................................................................................................................................................................... 8 Required disclaimer: IFT is a CFA Institute Prep Provider. Only CFA Institute Prep Providers are permitted to make use of CFA Institute copyrighted materials which are the building blocks of the exam. We are also required to create / use updated materials every year and this is validated by CFA Institute. Our products and services substantially cover the relevant curriculum and exam and this is validated by CFA Institute. In our advertising, any statement about the numbers of questions in our products and services relates to unique, original, proprietary questions. CFA Institute Prep Providers are forbidden from including CFA Institute official mock exam questions or any questions other than the end of reading questions within their products and services. CFA Institute does not endorse, promote, review or warrant the accuracy or quality of the product and services offered by IFT. CFA Institute®, CFA® and “Chartered Financial Analyst®” are trademarks owned by CFA Institute. © Copyright CFA Institute Version 1.0
LM07 Analysis of Long-Term Assets 2025 Level I Notes © IFT. All rights reserved 2 1. Introduction Long-term assets are defined as those assets that are expected to provide future economic benefits extending more than one year. These assets include:  Tangible assets also known as fixed assets or property, plant, and equipment. Examples include land, buildings, furniture, machinery, etc.  Intangible assets lack physical substance. Examples include patents, trademarks, etc. While a "economic" balance sheet would include a wide range of assets such as a company's reputation and its trained, experienced workforce, "accounting" balance sheets prepared in accordance with IFRS and US GAAP allow for the recognition of a narrow range of assets. There are two important questions in accounting for a long-term asset:  What cost should be shown on the balance sheet?  How should this cost be allocated over the life of an asset? 2. Acquisition of Intangible Assets Intangible assets lack physical substance. Classic examples include software, customer lists, patents, copyrights, and trademarks. Under IFRS, identifiable intangible assets must meet three definitional criteria. They must be:  Identifiable – either capable of being separated from the entity or arising from contractual or legal rights  Under the control of the company  Expected to generate future economic benefits In addition, two recognition criteria must be met:  It is probable that the expected future economic benefits of the asset will flow to the company.  The cost of the asset can be reliably measured Accounting for an intangible asset depends on how it is acquired. Acquired in a Business Combination This refers to a situation where one company buys another company and, in the process, acquires intangible assets.  Both IFRS and US GAAP require the use of acquisition method in accounting for business combinations. (This method will be studied in detail at Level II.)  Under the acquisition method, identifiable intangible assets such as patents, copyrights, and trademarks are recorded at their fair value.
LM07 Analysis of Long-Term Assets 2025 Level I Notes © IFT. All rights reserved 3  Goodwill is an intangible asset that cannot be identified separately. It is recorded when one business acquires another business. If the purchase price exceeds the fair value of the net identifiable assets (both the tangible assets and the identifiable intangible assets, minus liabilities) acquired. For example, Tan Hospitals Inc. acquires Man Equipments Inc. for $100 million. The fair value of Man Equipments’ net assets equal $95 million. In this case, the excess of $5 million will be recorded as goodwill. Purchased in Situations Other than Business Combinations This refers to a situation where an identifiable intangible asset is purchased, e.g. buying a patent from an inventor. The identifiable intangible asset is recorded at fair value which is assumed to be equal to the purchase price. Developed Internally Costs to internally develop intangible assets are generally expensed when incurred, although there are exceptions. The differences in whether the costs are capitalized or expensed affect financial statement ratios as outlined below:  Balance sheet: A company that develops intangible assets internally will expense costs and record lower assets compared to a company that acquires such assets through purchase.  Statement of cash flows: The costs of internally developing intangible assets are classified as operating cash flows, while the cost of acquiring intangible assets is classified as investing cash flows. For internally developed intangible assets, there are two phases: the research phase and the development phase. Research phase refers to the period during which commercial feasibility of an intangible asset is yet to be established. It is defined as “original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.” Development phase refers to the period during which the technical feasibility of completing an intangible asset has been established with the intent of either using or selling the asset. The treatment for the two phases varies slightly under IFRS and US GAAP as outlined below: Under IFRS:  Research costs are expensed.  Development costs can be capitalized if technical feasibility and the intent to sell the asset are established. Under US GAAP:  Both research and development costs are expensed, but there are exceptions for software development.  Software for sale: Costs incurred to develop a software product for sale are expensed
LM07 Analysis of Long-Term Assets 2025 Level I Notes © IFT. All rights reserved 4 until the product’s feasibility is established, and capitalized after the product’s feasibility has been established. Determining feasibility involves judgment.  Software for internal use: All development costs should be capitalized. Example Acme Inc. starts an internal software development project on January 1, 2012. It incurs expenditures of $10,000 per month during the fiscal year ended December 31, 2012. By March 31, it is clear that the product will be developed successfully and will be used as intended. How are the software development costs recorded before and after March 31 according to IFRS and US GAAP? Solution: IFRS: Under IFRS all costs are expensed until feasibility is established if the software is developed for internal use. So, $30,000 (period from January 1 to March 31, 2012) is expensed and $90,000 is capitalized (from April 1 to December 31, 2012). U.S GAAP: The entire cost of $120,000 should be capitalized. 3. Impairment and Derecognition of Assets Impairment of Assets Impairment charges reflect an unexpected decline in the fair value of an asset to an amount lower than its carrying amount (Whereas depreciation and amortization charges allocate the cost of a long-term asset over its useful life.) Under IFRS  An asset is impaired when its carrying value exceeds the recoverable amount.  The recoverable amount is the greater of (fair value less selling costs) and the (present value of expected cash flows from the asset, i.e., the value in use).  If impaired, the asset is written down to the recoverable amount.  Subsequent loss recoveries are allowed, but they cannot exceed the historical cost. Under US GAAP,  An asset is impaired if its carrying value is greater than the asset’s undiscounted future cash flows.  If impaired, the asset is written down to the fair value.  Subsequent loss recoveries are not allowed. Impact of Financial Statements When an asset is impaired the impact in that period is:  The value of the asset is written down.  Activity ratios such as sales/assets are higher.